L’économie à l’épreuve des faits

30 April, 2018 at 18:51 | Posted in Economics | Comments Off on L’économie à l’épreuve des faits

 

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Anatomie d’une triple crise

30 April, 2018 at 18:31 | Posted in Economics | Comments Off on Anatomie d’une triple crise

Des trois crises actuelles, l’environnementale est à la fois la moins immédiatement saisissable et sans doute la plus fondamentale au regard de l’effet transformateur qu’elle pourrait produire sur les sociétés. Il ne s’agit d’ailleurs pas à proprement parler d’une crise, laquelle suppose un « avant », un « pendant » et un « après » — une sortie de crise. Or, même à supposer que les pays industrialisés adoptent les mesures drastiques qui s’imposent en matière de réduction des émissions de gaz à effet de serre — et on en est loin —, le changement climatique provoque déjà des dégâts irréversibles. Ce que la « communauté internationale » peut faire, c’est limiter (considérablement) ces conséquences, mais non les inverser.

marPour y parvenir, il faut trouver des solutions audacieuses aux crises politique et économique. Le changement climatique offre une occasion de refonder la démocratie. L’adaptation des sociétés suppose de réorganiser de fond en comble la vie quotidienne des populations. Mais un tel bouleversement ne peut avoir lieu sans mobiliser ces dernières, sans s’appuyer sur leurs savoirs et leurs savoir-faire. La création de nouvelles institutions démocratiques à la base sera nécessaire.

En matière économique, l’annulation partielle ou totale de la dette publique représenterait une mesure écologique par excellence. Si l’État ne peut investir massivement dans la transition énergétique, c’est à cause d’une absence de volonté politique, mais aussi parce qu’il est prisonnier de ses créanciers. Crise politique, crise économique et crise écologique convergent, on le voit, en un seul et même problème.

Razmig Keucheyan / Le Monde diplomatique

On the road again

30 April, 2018 at 17:35 | Posted in Varia | Comments Off on On the road again

 

Respect is not a gift. It is something you have to earn!

29 April, 2018 at 17:55 | Posted in Economics | Comments Off on Respect is not a gift. It is something you have to earn!

respectEvery now and then yours truly gets some upset comments from people wondering why I’m not always respectful of people like Eugene Fama, Robert Lucas, Greg Mankiw, Edward Prescott, Thomas Sargent and others of the same ilk. Here’s a good hint at why it might sometimes be quite appropriate to be disrespectful:

Why can’t I be serious and respectful? Well, the answer is that we’re not having a serious conversation. There are real debates in economics — for example, about how much slack remains in the economy, how effective unconventional monetary policy really is, etc.. For those debates a respectful tone is appropriate. But when people resurrect 80-year-old fallacies, then claim that they never said what they said, then come right back with the same thing, we need colorful language to convey the deep unseriousness of their position.

Paul Krugman

A whiter shade of pale

29 April, 2018 at 17:10 | Posted in Varia | 1 Comment

 

Covers are as a rule worse than the original. But there are exceptions. This is certainly one of them. Annie Lennox — absolutely fabulous!

Me and Jane Austen in Karlsbad

29 April, 2018 at 16:57 | Posted in Varia | Comments Off on Me and Jane Austen in Karlsbad

karlsbadA couple of years ago, after a hectic week lecturing in Prague and Vienna, yours truly, of course, could not resist the temptation to make a stopover in Karlsbad (Karlovy Vary). It was like walking right into a novel by Jane Austen. Hopefully,​​ I will get time off for a new visit this summer.

Jean Tirole et la police de la pensée économique

29 April, 2018 at 15:08 | Posted in Economics | Comments Off on Jean Tirole et la police de la pensée économique

Police-de-la-pensée-viergePartisans de la concurrence non faussée, les économistes dominants la goûtent moins quand on les invite à la faire vivre dans leur profession. Reprenant une promesse de son prédécesseur Benoît Hamon, la ministre de l’éducation nationale Najat Vallaud-Belkacem s’était engagée en décembre 2014 à créer à titre expérimental une seconde section d’économie au sein du Conseil national des universités (CNU), l’organisme qui gère la carrière des enseignants-chercheurs. Intitulée « Institutions, économie, territoire et société », celle-ci aurait pu devenir un refuge pour les économistes hétérodoxes, mal aimés des représentants du courant dominant. L’école dite « néoclassique », qui repose sur l’hypothèse de la perfection des marchés et de la rationalité des individus, règne en effet depuis vingt ans sur l’actuelle section de sciences économiques, la «05». Trois cents chercheurs hétérodoxes se préparaient donc à rejoindre une nouvelle section d’économie politique pluraliste, critique et ouverte aux autres sciences sociales.

C’était sans compter le tir de barrage des « orthodoxes », bien décidés à tuer dans l’œuf toute possibilité d’une autre pensée économique. A peine avaient-ils eu vent du projet ministériel que le président de la « 05 », Alain Ayong Le Kama, envoyait un courrier au gouvernement, brandissant la menace d’une « démission collective » de la section. Mais l’offensive la plus décisive a été celle de Jean Tirole, lauréat en 2014 du prix de la banque de Suède en sciences économiques en mémoire d’Alfred Nobel (abusivement qualifié de « prix Nobel d’économie »). Il a adressé une lettre à Mme Vallaud-Belkacem pour empêcher une « catastrophe ». Mission accomplie : le projet a aussitôt été enterré.

Cette bataille apparemment corporatiste est en réalité hautement stratégique. Les représentations et préconisations des économistes exercent une forte influence sur les politiques publiques. Or, depuis une vingtaine d’années, les chercheurs hétérodoxes, c’est-à-dire tous ceux qui ne souscrivent pas à l’école néoclassique, soit à peu près un tiers des économistes français, sont exclus des positions-clés de la profession …

Cette hégémonie serait peut-être plus acceptable si elle n’allait pas de pair avec une abyssale faiblesse théorique. En 2007, la chose a commencé à se voir, même aux yeux de non-spécialistes. Non seulement les orthodoxes ont été incapables de prédire ou même de comprendre la crise des subprime, mais leurs hypothèses sur l’efficience des marchés avaient permis de légitimer scientifiquement la dérégulation financière qui en est en grande partie responsable …

Le retour en vogue de Keynes et de Karl Marx que l’on observe dans la presse et dans l’édition n’atteint pourtant pas le monde de la recherche, imperméable à toute remise en cause. Dans sa missive, Tirole s’enorgueillit des « centres d’excellence en économie qui ont émergé en France ces trois dernières décennies » et qui « forment aujourd’hui des économistes que les régulateurs, organismes internationaux et entreprises s’arrachent ». Le fait que ces « centres d’excellence » n’aient pas produit des économistes critiques, susceptibles d’alerter sur les dangers de la financiarisation, ne l’effleure manifestement pas. Droit dans ses bottes, il continue de mépriser souverainement les courants minoritaires, parlant d’eux comme d’un « ensemble hétéroclite en difficulté avec les normes d’évaluation internationalement reconnues », et les rappelle à l’ordre : « Chercher à se soustraire à ce jugement [des pairs] promeut le relativisme des connaissances, antichambre de l’obscurantisme. »

Laura Raim / Le Monde Diplomatique

Zwischen Freiheit und Unfreiheit gibt es keinen Mittelweg

29 April, 2018 at 11:08 | Posted in Politics & Society | Comments Off on Zwischen Freiheit und Unfreiheit gibt es keinen Mittelweg

Nun kommt es darauf an, dass der einzelne Migrant sich aus dem Würgegriff des Kollektivs befreit und seinen Weg in die freie Gesellschaft beschreitet. Sonst bleibt es dabei, dass unsere Integration gescheitert ist …

big_25c3a37b98Wer das nicht glaubt, sehe sich die Zahlen an: 43 Prozent aller Arbeitslosen haben einen Migrationshintergrund, die Frauenhäuser beherbergen überdurchschnittlich viele Migrantinnen, die Zahl der Salafisten in Deutschland hat sich in den letzten fünf Jahren verdoppelt, die Zahl der Gefährder hat sich in den letzten drei Jahren verdreifacht …

Integration ist keine Einbahnstraße, beide Seiten müssen etwas dafür tun – und beide müssen es wollen. Aufseiten der Migranten setzt Integration Widerstand voraus. Nein, Sie haben sich nicht verlesen. Wer sich in eine freie Gesellschaft integrieren will, muss sich weigern, Teil von unfreien Strukturen zu bleiben. Dazu braucht er Entscheidungsfreiheit. Eine patriarchale Kultur, die auf Ehre und Gehorsam setzt, räumt dem Einzelnen keine Freiheit ein. Die Mainstream-Theologie des Islams zwingt Muslime, sich entweder als Muslime oder als Europäer zu definieren. Deutschland muss sich endlich gegen diese Theologie und dieses Patriarchat abgrenzen. Zwischen Freiheit und Unfreiheit gibt es keinen Mittelweg …

Ich hoffe auf ein Deutschland, wo Menschen anderer Hautfarbe und anderer Religionen problemlos Deutsche sein können, wenn sie sich mit dem Land identifizieren und seine Werte bejahen. Die Trennlinie verliefe dann nicht mehr zwischen Migranten und “Biodeutschen”, zwischen Muslimen und Christen, sondern zwischen Demokraten und Nichtdemokraten.

Hamed Abdel-Samad / Die Zeit

Going Up The Country

28 April, 2018 at 18:22 | Posted in Varia | Comments Off on Going Up The Country

 

The Best Intentions

28 April, 2018 at 17:16 | Posted in Varia | 2 Comments

 

Bille August’s and Ingmar Bergman’s absolutely marvellous​ masterpiece.
With breathtakingly beautiful music by Stefan Nilsson.

Financial regulations

28 April, 2018 at 12:13 | Posted in Economics | 2 Comments

A couple of years ago, former chairman of the Fed, Alan Greenspan, wrote in an article in the Financial Times, re the increased demands for stronger regulation of banks and finance:

Alan Greenspan and Ayn Rand at the White House after Greenspan was sworn in as chairman of Gerald Ford’s Council of Economic Advisers, September 1974Since the devastating Japanese earthquake and, earlier, the global financial tsunami, governments have been pressed to guarantee their populations against virtually all the risks exposed by those extremely low probability events. But should they? Guarantees require the building up of a buffer of idle resources that are not otherwise engaged in the production of goods and services. They are employed only if, and when, the crisis emerges.

The buffer may encompass expensive building materials whose earthquake flexibility is needed for only a minute or two every century, or an extensive stock of vaccines for a feared epidemic that may never occur. Any excess bank equity capital also would constitute a buffer that is not otherwise available to finance productivity-enhancing capital investment.

That is — to say the least — astonishing. Not wanting to take genuine uncertainty or ‘fat tails’ seriously is ominous enough. Is there anything the year 2008 taught us, it is that the ‘tail risks’ are genuinely real and must be included in all financial calculations. But even worse is how someone – who surely ought to have read at least an introductory course in economics – can get the idea that demand for higher capital requirements of banks would be equivalent to building buffers of ‘idle resources.’ The claim is from an economist’s point of view absolute nonsense.

Capital requirements are about how the mix between debt and equity of banks’ balance sheets should look like. It is not a question of something having to be set aside. It is not about liquidity or reserve requirements. Capital requirements are not about pea soup in a jar that we should put on stock to have in a crisis. It’s about how much leverage we should allow banks to have.

Higher capital requirements simply mean that we demand that banks finance a larger portion of their portfolios out of equity and less out of money deposited or loans. There is nothing here about resource use, but about how banks should manage risks. And how they are distributed in an economically efficient manner.

Of course, higher capital requirements mean that banks’ risk-taking decrease. It is precisely because of this the requirements have been instituted. We saw in the recent financial crisis how the ‘systemic risk’ shot up when the banks were found to have taken on too great risks. Financial institutions authorized to operate with high leverage generate negative externalities. Of course, we have to — in the light of the financial crisis — ensure that banks operate under less leverage. Higher capital requirements are one way of achieving this.

Let me illustrate the mechanism.

Suppose a crisis would come and there would be a loss of 1 million USD, and the bank’s own capital is, for example, 5% of the balance sheet, that would force the bank to liquidate assets at a value of 20 million USD to regain the 5% level. Obviously, systems repercussions would be monumental. Higher capital requirements would both reduce the risk of liquidation, and the repercussions would be smaller (20% equity level would, in our example, reduce leverage to 5 million USD).

Suppose the initial balance sheet looks like this:

Loan: 100    Shareholders’ equity: 5
Liabilities: 95

Now if you raise the capital requirement from 5% to 20%, the bank can in principle react in three ways:

A: Assets Liquidation
Loan: 25   Equity: 5
Liabilities: 20

B: Recapitalization
Loan: 100 Shareholders’ equity: 20
Liabilities: 80

C: Assets Expansion
New assets: 12.5
Loans: 100  Shareholders’ equity: 22.5
Liabilities: 90

In both cases B and C it is evident that the higher capital requirements do not mean that the balance sheet must be reduced. Banks can continue to provide the economy with the necessary loans. Some negative effects on the banks’ ability to perform their basic system functions need not occur because one raises the capital requirements.

This is basics. That a former Federal Reserve chairman does not understand this is, to say the least, disheartening.

But maybe that is how it goes when you prefer reading Ayn Rand to Keynes or Minsky …

What we do in life echoes in eternity

28 April, 2018 at 10:48 | Posted in Varia | Comments Off on What we do in life echoes in eternity

ken

In science, courage is to follow the motto of enlightenment and Kant’s dictum — Sapere Aude!  To use your own understanding, having the ​courage to think for yourself and question ‘received opinion,’ authority or orthodoxy.

In our daily lives, courage is a capability to confront fear, as when in front of the powerful and mighty, not to step back, but stand up for one’s rights not to be humiliated or abused.

As when Rosa Parks sixty-three years ago, on December 1, 1955, in Montgomery, Alabama, refused to give up her seat to make room for a white passenger.

Courage is to do the right thing in spite of danger and fear.

As when Sir Nicholas Winton organised the rescue of 669 children destined for Nazi concentration camps during World War II.

222233Or as when Ernest Shackleton, in April 1916, aboard the small boat ‘James Caird’, spent 16 days crossing 1,300 km of ocean to reach South Georgia, then trekked across the island to a whaling station, and finally could rescue the remaining men from the crew of ‘Endurance’ left on the Elephant Island. Not a single member of the expedition died.

What we do in life echoes in eternity.

MMT — the Wicksell connection

27 April, 2018 at 19:02 | Posted in Economics | 4 Comments

Most mainstream economists seem to think the idea behind Modern Monetary Theory is something new that some wild heterodox economic cranks have come up with.

New? Cranks? How about reading one of the great founders of neoclassical economics — Knut Wicksell. This is what Wicksell wrote in 1898 on ‘pure credit systems’ in Interest and Prices (Geldzins und Güterpreise):

It is possible to go even further. There is no real need for any money at all if a payment between two customers can be accomplished by simply transferring the appropriate sum of money in the books of the bank

A pure credit system has not yet … been completely developed in this form. But here and there it is to be found in the somewhat different guise of the banknote system

We intend therefor, as a basis for the following discussion, to imagine a state of affairs in which money does not actually circulate at all, neither in the form of coin … nor in the form of notes, but where all domestic payments are effected by means of the Giro system and bookkeeping transfers. A thorough analysis of this purely imaginary case seems to me to be worth while, for it provides a precise antithesis to the equally imaginay case of a pure cash system, in which credit plays no part whatever [the exact equivalent of the often used neoclassical model assumption of ‘cash in advance’ – LPS] …

For the sake of simplicity, let us then assume that the whole monetary system of a country is in the hands of a single credit institution, provided with an adequate number of branches, at which each independent economic individual keeps an account on which he can draw cheques.

What Modern Monetary Theory (MMT) basically does is exactly what Wicksell tried to do more than a hundred years ago. The difference is that today the ‘pure credit economy’ is a reality and not just a theoretical curiosity — MMT describes a fiat currency system that almost every country in the world is operating under.

In modern times legal currencies are totally based on fiat. Currencies no longer have intrinsic value (as gold and silver). What gives them value is basically the simple fact that you have to pay your taxes with them. That also enables governments to run a kind of monopoly business where it never can run out of money. A fortiori, spending becomes the prime mover and taxing and borrowing is degraded to following acts. If we have a depression, the solution, then, is not austerity. It is spending. Budget deficits are not the major problem since fiat money means that governments can always make more of them.

Was als gerecht gilt

27 April, 2018 at 17:16 | Posted in Politics & Society | Comments Off on Was als gerecht gilt

91sJ2jEsGiLSchreiber: Anstatt den Muslimen zu sagen: “Werdet Teil dieser Gesellschaft”, hieß es: “Haltet euch von der westlichen Lebensweise fern. Seid nicht mit Christen befreundet. Geht raus und versucht zu missionieren.” Das waren – vorsichtig ausgedrückt – die Aufforderungen. Besonders krass fand ich die Aussage: “Ihr könnt nicht Muslime und Demokraten zugleich sein.” Die Predigten, die wir angemeldet filmten, hatten eine moderatere Tonalität. Das Phänomen kennt man als Journalist auch von Gesprächen mit Politikern und Wirtschaftsvertretern: Sobald eine Kamera dabei ist, wird anders gesprochen – ein ganz normaler menschlicher Vorgang. Bei manchen Predigten fiel mir selber erst hinterher auf, wo das Problem lag. Zum Beispiel beim Thema Gerechtigkeit.

ZEIT: Gegen Gerechtigkeit ist wenig einzuwenden.

Schreiber: Aber was als gerecht gilt, das ist von Land zu Land unterschiedlich. In einem Taliban-Staat ist es gerecht, wenn Frauen gesteinigt werden, weil sie angeblich Ehebruch begangen haben. In Saudi-Arabien ist es gerecht, dass man einem Dieb die Hand abhackt. In Deutschland ist genau das nicht gerecht und entspricht auch nicht unserem Verständnis von Gerechtigkeit. Es wird also vom Imam ein Wort in den Raum geworfen, und wenn man es kritisch hinterfragt, heißt es: Was willst du denn, der Imam sagt doch nur, man soll gerecht sein! Natürlich ist es ein positiver Begriff für uns, aber jeder versteht darunter etwas anderes. Die Unterscheidung mag pingelig erscheinen, ist aber keine Kleinigkeit.

Die Zeit

Solow’s Nobel Prize lecture

27 April, 2018 at 00:15 | Posted in Economics | 1 Comment

One of the achievements of growth theory was to relate equilibrium growth to asset pricing under tranquil conditions. The hard part of disequilibrium growth is that we do not have — and it may be impossible to have — a​ really good theory of asset valuation under turbulent conditions …

slide_19One important tendency in contemporary macroeconomic theory evades this problem in an elegant but (to me) ultimately implausible way. The idea is to imagine that the economy is populated by a single immortal consumer, or a number of identical immortal consumers. The immortality itself is not a problem: each consumer could be replaced by a dynasty, each member of which treats her successors as extensions of herself. But no short-sightedness can be allowed. This consumer does not obey any simple short-run saving function, nor even a stylized Modigliani life-cycle rule of thumb. Instead she, or the dynasty, is supposed to solve an infinite-time utility-maximization problem. That strikes me as far-fetched, but not so awful that one would not want to know where the assumption leads.

The next step is harder to swallow in conjunction with the first. For this consumer every firm is just a transparent instrumentality, an intermediary, a device for carrying out intertemporal optimization subject only to technological constraints and initial endowments. Thus any kind of market failure is ruled out from the beginning, by assumption. There are no strategic complementarities, no coordination failures, no prisoners’ dilemmas.

The end result is a construction in which the whole economy is assumed to be solving a Ramsey optimal-growth problem through time, disturbed only by stationary stochastic shocks to tastes and technology. To these the economy adapts optimally. Inseparable from this habit of thought is the automatic presumption that observed paths are equilibrium paths. So we are asked to regard the construction I have just described as a model of the actual capitalist world. What we used to call business cycles – or at least booms and recessions are now to be interpreted as optimal blips in optimal paths in response to random fluctuations in productivity and the desire for leisure.

I find none of this convincing. The markets for goods and for labor look to me like imperfect pieces of social machinery with important institutional peculiarities. They do not seem to behave at all like transparent and frictionless mechanisms for converting the consumption and leisure desires of households into production and employment decisions. I can not imagine shocks to taste and technology large enough on a quarterly or annual time scale to be responsible for the ups and downs of the business cycle.

Robert Solow

Moments you never forget (personal)

26 April, 2018 at 10:13 | Posted in Varia | Comments Off on Moments you never forget (personal)

68

Courage is a capability to confront fear, as when in front of the powerful and mighty, not to step back, but stand up for one’s rights not to be humiliated or abused.

Courage is to do the right thing in spite of danger and fear. To keep on even if opportunities to turn back are given.

Dignity, a better life, or justice and rule of law, are things worth fighting for. Not to step back — in spite of confronting the mighty and powerful — creates courageous acts that stay in our memories and means something — as the political demonstration conducted by Tommie Smith and John Carlos at the 1968 Summer Olympics in Mexico City.

I was ten years old at the time and following it all on TV. Moments like that you never forget. It has stayed with me for all these years.

DSGE models — false by construction

25 April, 2018 at 18:05 | Posted in Economics, Statistics & Econometrics | Comments Off on DSGE models — false by construction

Advances in mathematical tools and in economic theory rapidly changed the landscape. From the perspective of macroeconomics, the streamlined DSGE models of the 1980s begot much richer models in the 1990s. One remarkably successful extension was the introduction​ of nominal and real rigidities, i.e., the conception that agents cannot immediately adjust to changes in the economic environment. In particular, many of the new DSGE models focused on studying the consequences of limitations in how frequently or how easily agents can changes prices and wages (prices and wages are “sticky”). Since the spirit of these models seemed to capture the tradition of Keynesian economics, they quickly became known as New Keynesian DSGE models (Woodford, 2003) …

londonbridgefallingdown

One of the features of the New Macroeconometrics that the readers of this volume will find exciting is that the (overwhelming?) majority of it is done from an explicitly Bayesian perspective​ …

The Bayesian approach deals in a transparent way with misspecification and identification problems, which are pervasive in the estimation of DSGE models … After all, a DSGE model is a very stylized and simplified view of the economy that focuses only on the most important mechanisms at play. Hence, the model is false by construction​ and we need to keep this notion constantly in view …

Jesús Fernández-Villaverde et al.

Keep that “constantly in view.”

Hmm.

Seems some economists have a bad memory.

True Bromance

25 April, 2018 at 15:45 | Posted in Economics, Varia | Comments Off on True Bromance

 

The Lucas critique comes back with a vengeance in DSGE models

25 April, 2018 at 10:08 | Posted in Economics, Statistics & Econometrics | 3 Comments

Both approaches to DSGE macroeconometrics (VAR and Bayesian) have evident vulnerabilities, which substantially derive from how parameters are handled in the technique. In brief, parameters from formally elegant models are calibrated in order to obtain simulated values that reproduce some stylized fact and/or some empirical data distribution, thus relating the underlying theoretical model and the observational data. But there are at least three main respects in which this practice fails.

lucasFirst of all, DSGE models have substantial difficulties in taking account of many important mechanisms that actually govern real economies, for example, institutional constraints like the tax system, thereby reducing DSGE power in policy analysis … In the attempt to deal with this serious problem, various parameter constraints on the model policy block are provided. They derive from institutional analysis and reflect policymakers’ operational procedures. However such model extensions, which are intended to reshape its predictions to reality and to deal with the underlying optimization problem, prove to be highly unflexible, turning DSGE into a “straitjacket tool” … In particular, the structure imposed on DSGE parameters entails various identification problems, such as observational equivalence, underidentification, and partial and weak identification.

These problems affect both empirical DSGE approaches. Fundamentally, they are ascribable to the likelihoods to estimate. In fact, the range of structural parameters that generate impulse response functions and data distributions fitting very close to the true ones does include model specifications that show very different features and welfare properties. So which is the right model specification (i.e., parameter set) to choose? As a consequence, reasonable estimates do not derive from the informative contents of models and data, but rather from the ancillary restrictions that are necessary to make the likelihoods informative, which are often arbitrary. Thus, after the Lucas’s super-exogeneity critique has been thrown out the door, it comes back through the window.

Roberto Marchionatti & Lisa Sella

Our admiration for technical virtuosity should not blind us to the fact that we have to have a cautious attitude towards probabilistic inferences in economic contexts. We should look out for causal relations, but econometrics can never be more than a starting point in that endeavour since econometric (statistical) explanations are not explanations in terms of mechanisms, powers, capacities or causes. Firmly stuck in an empiricist tradition, econometrics is only concerned with the measurable aspects of reality, But there is always the possibility that there are other variables – of vital importance and although perhaps unobservable and non-additive not necessarily epistemologically inaccessible – that were not considered for the model. Those who were can hence never be guaranteed to be more than potential causes, and not real causes. A rigorous application of econometric methods in economics really presupposes that the phenomena of our real world economies are ruled by stable causal relations between variables. The endemic lack of predictive success of the econometric project indicates that this hope of finding fixed parameters is a hope for which there really is no other ground than hope itself.

This is a more fundamental and radical problem than the celebrated ‘Lucas critique’ have suggested. This is not the question if deep parameters, absent on the macro-level, exist in ‘tastes’ and ‘technology’ on the micro-level. It goes deeper. Real world social systems are not governed by stable causal mechanisms or capacities.

The kinds of laws and relations that econom(etr)ics has established, are laws and relations about entities in models that presuppose causal mechanisms being atomistic and additive. When causal mechanisms operate in real-world social systems they mostly do it in ever-changing and unstable combinations where the whole is more than a mechanical sum of parts. If economic regularities obtain they do it (as a rule) only because we engineered them for that purpose. Outside man-made ‘nomological machines’ they are rare, or even non-existant. Unfortunately that also makes most of the achievements of econometrics rather useless.

Both the ‘Lucas critique’ and the ‘Keynes’ critique’ of econometrics argued that it was inadmissible to project history on the future. Consequently an economic policy cannot presuppose that what has worked before, will continue to do so in the future. That macroeconomic models could get hold of correlations between different ‘variables’ was not enough. If they could not get at the causal structure that generated the data, they were not really ‘identified’. Lucas himself drew the conclusion that the problem with unstable relations was to construct models with clear microfoundations where forward-looking optimizing individuals and robust, deep, behavioural parameters are seen to be stable even to changes in economic policies. As yours truly has argued in a couple of posts — e. g. here and here — this, however, is a dead end.

The loanable funds fallacy

24 April, 2018 at 14:26 | Posted in Economics | 2 Comments

The loanable funds theory is in many regards nothing but an approach where the ruling rate of interest in society is — pure and simple — conceived as nothing else than the price of loans or credits set by banks and determined by supply and demand — as Bertil Ohlin put it — “in the same way as the price of eggs and strawberries on a village market.”

loanIt is a beautiful fairy tale, but the problem is that banks are not barter institutions that transfer pre-existing loanable funds from depositors to borrowers. Why? Because, in the real world, there simply are no pre-existing loanable funds. Banks create new funds — credit — only if someone has previously got into debt! Banks are monetary institutions, not barter vehicles.

In the traditional loanable funds theory — as presented in mainstream macroeconomics textbooks — the amount of loans and credit available for financing investment is constrained by how much saving is available. Saving is the supply of loanable funds, investment is the demand for loanable funds and assumed to be negatively related to the interest rate. Lowering households’ consumption means increasing savings via a lower interest.

That view has been shown to have very little to do with reality. It’s nothing but an otherworldly neoclassical fantasy. But there are many other problems as well with the standard presentation and formalization of the loanable funds theory:

As already noticed by James Meade decades ago, the causal story told to explicate the accounting identities used gives the picture of “a dog called saving wagged its tail labelled investment.” In Keynes’s view — and later over and over again confirmed by empirical research — it’s not so much the interest rate at which firms can borrow that causally determines the amount of investment undertaken, but rather their internal funds, profit expectations and capacity utilization.

As is typical of most mainstream macroeconomic formalizations and models, there is pretty little mention of real-world phenomena, like e. g. real money, credit rationing and the existence of multiple interest rates, in the loanable funds theory. Loanable funds theory essentially reduces modern monetary economies to something akin to barter systems — something they definitely are not. As emphasized especially by Minsky, to understand and explain how much investment/loaning/crediting is going on in an economy, it’s much more important to focus on the working of financial markets than staring at accounting identities like S = Y – C – G. The problems we meet on modern markets today have more to do with inadequate financial institutions than with the size of loanable-funds-savings.

The loanable funds theory in the ‘New Keynesian’ approach means that the interest rate is endogenized by assuming that Central Banks can (try to) adjust it in response to an eventual output gap. This, of course, is essentially nothing but an assumption of Walras’ law being valid and applicable, and that a fortiori the attainment of equilibrium is secured by the Central Banks’ interest rate adjustments. From a realist Keynes-Minsky point of view, this can’t be considered anything else than a belief resting on nothing but sheer hope. [Not to mention that more and more Central Banks actually choose not to follow Taylor-like policy rules.] The age-old belief that Central Banks control the money supply has more an more come to be questioned and replaced by an ‘endogenous’ money view, and I think the same will happen to the view that Central Banks determine “the” rate of interest.

A further problem in the traditional loanable funds theory is that it assumes that saving and investment can be treated as independent entities. This is seriously wrong:

gtThe classical theory of the rate of interest [the loanable funds theory] seems to suppose that, if the demand curve for capital shifts or if the curve relating the rate of interest to the amounts saved out of a given income shifts or if both these curves shift, the new rate of interest will be given by the point of intersection of the new positions of the two curves. But this is a nonsense theory. For the assumption that income is constant is inconsistent with the assumption that these two curves can shift independently of one another. If either of them shifts​, then, in general, income will change; with the result that the whole schematism based on the assumption of a given income breaks down … In truth, the classical theory has not been alive to the relevance of changes in the level of income or to the possibility of the level of income being actually a function of the rate of the investment.

There are always (at least) two parts in an economic transaction. Savers and investors have different liquidity preferences and face different choices — and their interactions usually only take place intermediated by financial institutions. This, importantly, also means that there is no ‘direct and immediate’ automatic interest mechanism at work in modern monetary economies. What this ultimately boils done to is — iter — that what happens at the microeconomic level — both in and out of equilibrium —  is not always compatible with the macroeconomic outcome. The fallacy of composition (the ‘atomistic fallacy’ of Keynes) has many faces — loanable funds is one of them.

Contrary to the loanable funds theory, finance in the world of Keynes and Minsky precedes investment and saving. Highlighting the loanable funds fallacy, Keynes wrote in “The Process of Capital Formation” (1939):

Increased investment will always be accompanied by increased saving, but it can never be preceded by it. Dishoarding and credit expansion provides not an alternative to increased saving, but a necessary preparation for it. It is the parent, not the twin, of increased saving.

What is ‘forgotten’ in the loanable funds theory, is the insight that finance — in all its different shapes — has its own dimension, and if taken seriously, its effect on an analysis must modify the whole theoretical system and not just be added as an unsystematic appendage. Finance is fundamental to our understanding of modern economies, and acting like the baker’s apprentice who, having forgotten to add yeast to the dough, throws it into the oven afterwards, simply isn’t enough.

All real economic activities nowadays depend on a functioning financial machinery. But institutional arrangements, states of confidence, fundamental uncertainties, asymmetric expectations, the banking system, financial intermediation, loan granting processes, default risks, liquidity constraints, aggregate debt, cash flow fluctuations, etc., etc. — things that play decisive roles in channelling money/savings/credit — are more or less left in the dark in modern formalizations of the loanable funds theory.

It should be emphasized that the equality between savings and investment … will be valid under all circumstances.kalecki In particular, it will be independent of the level of the rate of interest which was customarily considered in economic theory to be the factor equilibrating the demand for and supply of new capital. In the present conception investment, once carried out, automatically provides the savings necessary to finance it. Indeed, in our simplified model, profits in a given period are the direct outcome of capitalists’ consumption and investment in that period. If investment increases by a certain amount, savings out of profits are pro tanto higher …

One important consequence of the above is that the rate of interest cannot be determined by the demand for and supply of new capital because investment ‘finances itself.’

So, yes, the ‘secular stagnation’ will be over, as soon as we free ourselves from the loanable funds theory — and scholastic gibbering about ZLB — and start using good old Keynesian fiscal policies.

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